Pramerica to focus on ‘liquid’ UK and Germany for latest debt fund

Pramerica Real Estate Investors will home in on the UK and Germany for its third debt fund, Pramerica Real Estate Capital III, according to Andrew Radkiewicz, one of the fund’s two managers.

Pramerica closed Pramerica Real Estate Capital III at the end of April, following commitments of €260 mln which can be increased by a further €260 mln once the first tranche has been invested, likely within the next year, Radkiewicz said. It will focus on directly originated junior debt, according to Radkiewicz: ‘We target junior debt positions ranging between 30% and 75% of the capital stack. However, because we invest ungeared equity, the underlying real estate quality is the key driver, not just LTVs,’ he added. The fund will not invest in any secondary debt.

Pramerica is the European arm of the real estate investment and advisory business of US-based Prudential Financial, Inc.

The new debt vehicle will focus on office and retail properties in the UK and Germany, Radkiewicz said. ‘We would be happy to target up to a 50/50 split, as these are the largest and most liquid real estate markets in Europe. For offices, we look for strong fundamentals in key business districts, focusing on the main cities, such as London, Manchester and Birmingham in the UK and the ‘Big 6’ in Germany. Retail, however, is different as the location is much more important - we would only lend on retail assets in dominant locations with good demographics,’ he added.

PreCap III has a target annual return of between 8% and 10%, which is predominately income driven. ‘Typically, we would underwrite loans of between €5 mln and €100 mln, although we certainly have the capacity to go higher than €100 mln, without the need to club the deal,’ Radkiewicz said.

And while the junior/mezzanine debt market may be quite ‘blurred’, there is an increasing number of non-senior debt funds today, generating a typical annual return of between 8% and 16%, according to said Luca Giangolini, a partner in C&W’s corporate finance team in London. ‘It’s a wide range due to the underlying assets. For example, for core junior debt with a senior lender and plenty of interest cover, you’re looking at a single-digit return,’ he said.

In addition, Pramerica is mulling a follow-on debt fund, according to Radkiewicz. ‘As we evolve, it is likely in the reasonably near future that we could roll out our broader debt strategy for global investors, which could potentially have a similar target size to our first debt fund, which is now €500 mln,’ he added.

Pramerica has raised €1.1 bn over the past two years from institutional investors in the US, Europe and the Middle East to invest in its debt funds. As a result, it has made 18 loans totalling €550 mln in the past two years, secured on €2.8 bn of European real estate, largely in the UK and Germany.

The biggest investor in the latest fund is Dutch pension manager APG, which has invested the ‘vast majority of equity’ in the fund, Roland Mangelmans, senior portfolio manager, real estate, at APG Asset Management, told PropertyEU, although he declined to provide further details. According to Mangelmans, opportunities in the European debt market have become more attractive over the last couple of years. ‘APG has selective strategies towards real estate debt which mostly differ to traditional (senior) real estate debt lenders,’ he said. In total, APG has more than €325 bn of AUM with roughly 10% dedicated to real estate.

Institutional players such as APG are the main investors in debt funds, along with insurance firms, because they are attracted to the returns on offer in a challenging climate. ‘They are looking at the subordinated debt market because of the higher returns, which is a very valid investment rationale,’ said Giangolini at C&W. ‘However, there is still more talk than action from some would-be investors, who are still researching the market,’ he added.

Debt funds have certainly evolved in recent years. In the late 1990s, there was no real mezzanine market as banks were doing loans at LTVs of as much as 85% and then syndicating them. Now, the senior debt market is more conservative, which has led to a new wave of mezzanine lenders entering the market. ‘However, as competition has increased, lenders either have to increase risk to generate higher returns or to lower their return expectations,’ Giangolini added. In addition to Pramerica, other active players in the market include European mezzanine lender DRC Capital and US-based private investment group Starwood Capital.

In the first quarter of this year, there were 38 senior and mezzanine debt funds in the pipeline of raising capital, according to Mike King, a senior analyst at C&W in London. Based on the minimum target fund size, this suggests that the funds are looking to raise €24.6bn. This is up from 15 funds in the same period last year, according to King. ‘However, the likelihood of all these funds reaching a close is unlikely. Given the competition, fund managers are having to work hard to secure capital and, on top of this, due diligence requirements can be onerous,’ he said.

According to Preqin, $8.7bn (€6.6bn) of capital was raised by 34 European real estate funds in 2012. Nonetheless, this is down considerably from a peak of $33.5bn (€25.6bn) in 2007, when 127 such funds raised capital.